Flotation Cost

What Is a Flotation Cost?

A flotation cost is the total expense a company pays to sell new securities to investors. It covers fees and charges tied to the offering itself, so the company receives less money than investors pay. The largest component is usually the underwriting spread paid to the underwriter, the bank or brokerage that helps market and sell the securities. Other costs include legal fees, accounting and audit work, registration and filing fees, printing, and listing charges.

How Flotation Costs Work

When a company issues securities, the price investors pay is called the offering price. The company keeps the offering price minus flotation costs, which is its net proceeds. The relationship can be written as:

Net proceeds = Offering price - Flotation costs

Because the company receives less than the headline price, it must earn a return on the raised money that covers these costs before it creates value for shareholders.

Why Flotation Costs Matter

Flotation costs raise the effective price of outside financing. In capital budgeting and cost of capital analysis, analysts sometimes adjust the cost of new equity upward to account for these expenses. Flotation costs are generally higher for new stock than for new debt, and they tend to be a larger share of the amount raised for smaller offerings, because many fixed charges are spread over fewer dollars.

Companies that fund projects with retained earnings generally avoid these costs, which is one reason internal funding is often compared with issuing new shares. For investors, flotation costs are a reminder that the amount a company raises is not the same as the price paid by buyers, and they are typically disclosed in the offering documents.